Macroeconomic Determinants of Carry Trade Activity


  • Alessio Anzuini,

    Corresponding author
    1. Economic Research Department, Bank of Italy
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  • Fabio Fornari

    Corresponding author
    1. European Central Bank, Germany
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    • We thank for comments two anonymous referees, Renee Fry, Wolfgang Lemke, the participants at the conference Advances in International Economics and Economic Dynamics, held in honor of Giancarlo Gandolfo in Roma, 20–21 September 2010 and especially the discussant, Francesco Nucci. Thanks are also due to the participants in seminars held at the Warwick Business School and the Cass Business School in May 2011 and especially to Pasquale della Corte, as well as those in the informal FX workshop held at the Bank of Italy on 21 December 2011. Ines Van Robays provided computational assistance. We are solely responsible for any errors and the opinions expressed in this paper do not necessarily reflect those of the European Central Bank nor those of Banca d'Italia or the Eurosystem. The first draft of this paper was written while the first author was on leave in the Directorate General Economics of the European Central Bank.

Fornari, European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany. Tel: +49 (0)69 1344 8354; E-mail: Anzuini: Economic Research Department, Bank of Italy. E-mail:


Carry trades—popular strategies in the foreign exchange market—are long positions in high interest rate currencies financed through funds borrowed from low interest rate currencies. It has been shown for a number of bilateral exchange rates vis-à-vis the US dollar that shocks to interest rate differentials foster carry trade activity and lead to significant changes in the foreign exchange level. This paper considers which (or which combination of) structural shocks can be consistent with the implications of such an interest rate differential shock that has been identified in previous studies. It is especially demand and confidence shocks, rather than supply or monetary policy shocks, which are found to generate effects similar to those produced by an unexpected widening of the interest rate differential and overall lead to longer-term gains from carry trade activity. Also provided is a measure of the potential gain/losses experienced by the actual positioning of market participants in the foreign exchange futures and conditional on the knowledge of the macroeconomic shock that occurred at the time of positioning.